Quick Service Food & Beverage Intro – December 15, 2023
Setup
Over the next quarter or so, I will be publishing investment case articles on companies in the quick service restaurant (QSR) industry. To avoid sending a 100-page article, I’m going to send out mini dives into two companies from the landscape at a time. The first piece will be published later this month and will cover Cava and Sweetgreen.
I think this is a better format than the prior deep dives. It will be 90% as detailed as those were, with 100% of the important detail, and I’ll be able to send them out more frequently. This way, the information will be more current and more digestible. Furthermore, I think this approach will give you a better view of my investment thought process. It will also allow you to learn more about the sector overall and compare similar business models. As generalists, it is easier to build conviction by studying multiple companies in a sector rather than a single company in isolation. This tweak is my way of pulling back the curtain on how I dissect a new sector.
Sector Demand Intro
Quick service is a wonderfully stable secular growth story. Around 1992, per FRED, monthly grocery sales of roughly $28 billion were 63% larger than total restaurant service volume. Today, that has entirely flipped with $93 billion in monthly restaurant volume. That’s 25% larger than the grocery space as a whole. The 5.6% compounded annual growth rate (CAGR) for restaurants leaves a compelling opportunity for share takers in the sector. Depending on which research vendor we trust, forward CAGR expectations range from 6%-10% over the next several years. There’s no slowdown in sight.
Notably, food and drink service growth did flatline during the great financial crisis and did tank during the pandemic. Still, the sector has shown impressive resilience in its ability to recapture solid, run-rate growth in excess of U.S. GDP growth. Consumers, more and more, are leaning on restaurants for consumption as younger generations flock to services over goods. That reality has been turbo-charged by the proliferation of convenient delivery options. That is the growth setup for the sector.
Source: Brad Freeman – SEC Filings, Company Presentations, and Company Press Releases
Sector Margin Intro
Aggressive, macro-based margin headwinds are easing. Input cost inflation of raw ingredients continues to tumble, which helps all QSR margins (assuming at least constant menu pricing). It’s much harder to maintain traffic and profitability with a CPI at 8%. Few companies have the ability to hike menu prices at that clip to hold margins steady. It’s a lot easier to maintain or even grow margin with a CPI falling towards 2%.
A more gradual pace of input cost inflation allows chains to avoid sticker shock in their quest for margin preservation and makes traffic easier to maintain. In some cases, as we’ll see in the deep dives, price growth for some input costs like salmon has actually turned negative for players like Sweetgreen.
Further, in terms of expansion, the falling cost of capital should accelerate the pace and profitability of new restaurant chain openings as expansion becomes cheaper. Sky-high rates have weighed heavily on fixed business investments. Now, they appear to have peaked. That is the simplistic set-up. Using this as the 30,000 foot view, we are set to explore specific company investment cases. Expect the first part of this sector dive to be published this month.
